The infrastructure sector: unique rating drivers. February 2018

Transcription

1 The infrastructure sector: unique rating drivers February 2018

2 Criteria contacts Pawan Agrawal Chief Analytical Officer CRISIL Ratings Sameer Charania Director Rating Criteria and Product Development Somasekhar Vemuri Senior Director Rating Criteria and Product Development Sushmita Majumdar Director CRISIL Ratings In case of any feedback or queries, you may write to us at 2

3 Executive summary The infrastructure sector comprises entities ranging from service providers in power, telecommunications (telecom), mining, and transport, to state governments and urban local bodies (ULBs). The rating drivers are quite different from those applicable to entities in the corporate sector. For instance, government policy influences entities in the infrastructure sector much more than others. Again, unlike the corporate sector, the infrastructure sector has supplyside constraints in many segments. In many cases, the tariff charged for services provided is not driven by market conditions but by decisions of the government or regulator. Demand-related risks are minimal, especially in power, telecom, and urban infrastructure, whereas demand growth is a key credit driver in the manufacturing sector. Such divergences in the key rating drivers warrant a separate framework for evaluating infrastructure sector companies (refer Box 1 for categories of CRISIL-rated entities), vis-à-vis their counterparts in other sectors. This article details the key rating drivers impacting the credit quality of entities in the infrastructure sector. It also explains how these drivers differ from those of companies in the manufacturing and service sectors. Box 1: Categories of CRISIL-rated infrastructure sector entities Basic infrastructure service providers with moderate commercial viability: these include water and sewerage service boards, state transport corporations, and state government power generators, transmitters, and distributors Commercial service providers: these include telecom service providers, aviation infrastructure providers, toll road operators, central/independent power generators and transmitters, and oil and natural gas sector companies Special-purpose vehicles (SPVs) floated by State and local self-governments: these include municipal corporations and municipalities, and SPVs in different sectors such as irrigation and roads, with minimal commercial viability, seeking ratings that are supported by guarantees from the state governments. Scope The broader criteria of manufacturing companies 1 applies to entities in the sector. However, this article 2 highlights some of the common features that are unique to the infrastructure sector. It also outlines how CRISIL views each of these risk issues. The detailed criteria documents that capture the sector specific nuances for the following subsectors within infrastructure are published separately and are available on Criteria for Rating Solar Power Projects Criteria for Rating power transmission projects 1 The detailed criteria is on the CRISIL website under the Criteria and Methodology section Rating Criteria for Manufacturing and services sector companies and CRISIL s approach to financial ratios 2 For accessing previous published document on The Infrastructure Sector: Unique Rating Drivers, Kindly follow below mentioned link: Ratings-crieria-infra-unique-rat-drivers_2007.pdf 3

4 Criteria for rating wind power projects Rating Criteria for Mobile Telephony Services Criteria for Rating Municipal and Urban Local Bodies Rating Criteria for Power Distribution Utilities Rating Criteria for Power Generation Utilities CRISIL's criteria for rating annuity road projects Rating Criteria for Toll Road Projects Business risk These mainly include pricing flexibility and government policy, which have significant bearing on the viability of operations. Pricing flexibility In the corporate sector, prices tend to be market-driven and players enjoy greater pricing flexibility. In the infrastructure sector, however, pricing flexibility is relatively limited because the government determines much of the tariff. Power and telecom sectors are, nevertheless, better off: prices in these sectors (partially in case of telecom) are determined by regulatory commissions rather than the government. The goods and services offered cover mostly basic needs such as water, power, telecom, and transport. Revisions in the prices of these tend to have a significant impact on large sections of the population. Price revisions therefore constitute a sensitive issue and come under heavy scrutiny from political parties and the media. As a result, government influences the tariff to be charged for goods/services such as state transport, petroleum products, aviation, and water and sewerage services. At times, despite a surge in the prices of crude oil, the government does not permit raising the prices of finished goods, resulting in large losses for the OMCs. As a result, the pricing flexibility of the players in these sectors is very limited, a factor CRISIL views unfavourably. In the case of power and telecom sectors, regulatory authorities influence or determine tariff. This helps to ensure a better balance between the interests of the service provider and the consumer. The State Electricity Regulatory Commissions (SERCs), for instance, determine tariff for the power sector after giving due consideration to the interests of the various user segments, while at the same time ensuring fair returns to licensees. CRISIL therefore views entities whose tariff structures are determined by regulators favourably when compared with those determined by the government; such entities tend to have healthy financial returns, and their tariff is generally independent of government intervention. CRISIL views the presence of independent regulators as a key positive. In case of entities with government-influenced prices, the credit view would be driven by the extent of the influence. In the corporate sector, prices are market-driven and determined by factors such as the demand-supply situation and import parity. Pricing flexibility is therefore a significant differentiator between the credit quality of an infrastructure entity and a corporate sector player. 4

5 Government policy Government policy is a central rating driver. At times, government intervention strengthens the credit risk profiles, while at others, it constrains them. Traditionally, government policy has played an important role and this is centrally factored in the assessment of credit risk profiles of the players. However, the impact of the government's role may vary. There have been instances where government influence has been a positive factor driving the ratings; for example, petrol and diesel cess passed on to entities such as National Highways Authority of India (NHAI) or tax exemptions to investors on borrowing programmes of infrastructure entities. There are also instances when government intervention has proved to be a bane. These include the following: Lack of clarity in regulations in the telecom sector in the past had resulted in increased risk perceptions for the sector as a whole. The government's reluctance to raise retail prices on petroleum products despite the rising crude prices led to large losses for the OMCs. Water and waste-water services provided by the ULBs are usually priced uneconomically; there are many instances when tariff for the domestic segment has not been revised for over 10 years. The government offers no fund-based or non-fund-based support to entities that are not in the infrastructure sector. The government's role is largely limited to making policies for the various industries. Consequently, the credit risk profiles of corporate sector entities are typically not impacted by government influence. The credit risk profiles of several infrastructure sector entities, however, have close linkages with government policies. CRISIL views government's influence on business and financial risks of the rated entities on a holistic basis in assessing their creditworthiness. Demand risk Generally, there is a favourable demand-supply situation in the infrastructure industry; in most cases, demand outstrips supply. In sectors such as water supply, airports, and urban infrastructure, the demand-supply gap is significant. Though the government encourages private investment in these sectors, a considerable portion of demand remains unmet. Demand risks are likely to remain low over the medium-term; this reflects favourably on the credit risk profiles of the players. In the corporate sector, demand risks play a significant role in ascertaining business risks. Industries with unfavourable demand-supply situations come under considerable stress: they face either a reduction in operating rates or decline in realisations. This, in turn, impacts the overall financial risk profile. CRISIL factors in the low demand risks in the infrastructure sector favourably in its credit risk assessment framework. Monopoly business Monopoly alone does not improve the credit risk profile; the ability to earn profits is critical. The government has, in the past, created several monopoly entities such as Airports Authority of India (AAI), Bharat Sanchar Nigam Limited (BSNL), and state electricity boards (SEBs) that were intended to be both economically viable and socially responsible. At times, the government uses these entities to further its own social, political, or economic objectives. 5

6 Hence, despite being in a monopoly business, these entities often suffer losses due to government interventions in pricing. For instance, till the late 1990s, the state governments determined the respective SEB's power tariff, and rational increases in tariff were not allowed. Consequently, the SEBs had huge losses. On the other hand, some monopolies registered good profits. For instance, the increasing congestion at airports led to sharp deterioration in the service quality of AAI, which, nevertheless, had large profits. The capability to effectively use the monopoly status to generate high profits is key to ensuring a favourable credit risk profile. The corporate sector is largely competitive, barring a few exceptions such as the petrochemicals sector where individual entities such as Reliance Industries Ltd command a large market share. Prices in the petrochemicals sector are, however, linked to import parity prices, thereby ensuring rational pricing. Therefore, a sizeable market share is generally viewed favourably in the corporate sector. CRISIL's view is contingent upon the impact of the monopoly status on the profitability of players. Financial risk With the exception of state governments and ULBs, the financial risk analysis framework for all entities in the infrastructure sector is similar to that of entities in the corporate sector. It has four components: Existing financial position Future financial risk profile Cash flow adequacy Financial flexibility The key financial parameters that are analysed include trends in revenue from operations, an analysis of cost and profitability, management of receivables and payables, coverage ratios, return on capital employed, and debt analysis. The parentage, track record in raising funds, and trends in cash generated from operations are analysed to ascertain financial flexibility. To ascertain the future financial risk profile, CRISIL analyses operational and financial projections, and predicts the adequacy of projected flows to meet financial obligations after adjusting for expected capital expenditure, operational expenses, and working capital requirement. Unlike the corporate sector, where making profits is a key objective, sub-sovereign and local governments are not primarily driven by financial and economic objectives but by larger social objectives. Attaining these entails significant expenditure. However, their financials are not comparable with those of the corporates given their ability to raise funds either by way of borrowings or taxes. Therefore, CRISIL uses a different financial risk assessment framework for ULBs and state governments, covered separately. Management risk CRISIL follows the standard criteria used for all manufacturing companies. This is presented in detail in the CRISIL publication, Rating Criteria for Manufacturing and Services sector Companies. 6

7 Conclusion CRISIL's rating criteria for the infrastructure sector are unique, because entities in this sector have very dissimilar attributes, unlike those in the corporate sector. The dominant roles that governments play in policymaking, pricing flexibility, and management are key to determining the credit risk profiles of government-controlled entities. At times, governments use the entities to further their own social, political, and economic objectives, which constrains the ratings. 7

8 About CRISIL Limited CRISIL is an agile and innovative, global analytics company driven by its mission of making markets function better. We are India s foremost provider of ratings, data, research, analytics and solutions. A strong track record of growth, culture of innovation and global footprint sets us apart. We have delivered independent opinions, actionable insights, and efficient solutions to over 100,000 customers. We are majority owned by S&P Global Inc., a leading provider of transparent and independent ratings, benchmarks, analytics and data to the capital and commodity markets worldwide. About CRISIL Ratings CRISIL Ratings is part of CRISIL Limited ( CRISIL ). We pioneered the concept of credit rating in India in CRISIL is registered in India as a credit rating agency with the Securities and Exchange Board of India ( SEBI ). With a tradition of independence, analytical rigour and innovation, CRISIL sets the standards in the credit rating business. We rate the entire range of debt instruments, such as, bank loans, certificates of deposit, commercial paper, non-convertible / convertible / partially convertible bonds and debentures, perpetual bonds, bank hybrid capital instruments, assetbacked and mortgage-backed securities, partial guarantees and other structured debt instruments. We have rated over 24,500 large and mid-scale corporates and financial institutions. CRISIL has also instituted several innovations in India in the rating business, including rating municipal bonds, partially guaranteed instruments and microfinance institutions. We also pioneered a globally unique rating service for Micro, Small and Medium Enterprises (MSMEs) and significantly extended the accessibility to rating services to a wider market. Over 1,10,000 MSMEs have been rated by us. CRISIL Privacy Notice CRISIL respects your privacy. We use your contact information, such as your name, address, and id, to fulfil your request and service your account and to provide you with additional information from CRISIL and other parts of S&P Global Inc. and its subsidiaries (collectively, the Company ) you may find of interest. For further information, or to let us know your preferences with respect to receiving marketing materials, please visit You can view the Company s Customer Privacy at Last updated: April 2016 Argentina China Hong Kong India Poland Singapore UK USA CRISIL Limited: CRISIL House, Central Avenue, Hiranandani Business Park, Powai, Mumbai India Phone: Fax: